Derivatives may prove to be hazardous tools : an analysis of the financial disasters associated with derivatives

Abstract

One of the most important fundamental structural changes in the nature of the operation and interaction of the global financial system was the literal explosion of the use of derivatives. These instruments are revolutionizing the financial industry and changing the way banks, institutional investors, and securities traders do business domestically and globally. Though not new, derivatives have just recently grabbed the spotlight as vehicles that can diversify portfolio risks. While potentially beneficial, these important instruments are complex structures that are often misunderstood and frequently mishandled. Such misunderstanding was the key to the string of :financial disasters that took place in the 1990s. It seemed that derivatives risks were bitterly learned at the expense of millions of losses incurred by many institutions. To fully grasp the risks of derivatives this dissertation presents an in depth analysis of the risks involved in derivatives transactions, followed by a separate in depth analysis of three major derivatives debacles. The extraordinary increase in the use of financial derivatives, along with highly publicized disasters had a significant impact on financial institutions, individual investors and national economies. Consequently as their dark side was revealed, their status changed. This led to calls for new regulations and an international harmonization the regulatory and supervision framework.